Forex Brokers That Allow Hedging: A Comprehensive Guide
Hedging is a popular risk management strategy among forex traders, offering a way to mitigate potential losses and smooth out market fluctuations. With an array of brokers allowing this technique, it’s essential for traders to understand the benefits and drawbacks of hedging and how to choose the right broker. In this comprehensive guide, we’ll cover everything you need to know about forex brokers that allow hedging, including the legality, how to select the best broker, and various strategies employed in hedging.
Is Hedging Legal?
Hedging in forex trading is not technically illegal, and it’s a common technique among traders looking to balance their risk effectively. However, some individual brokers may not allow hedging based on their own policies. Additionally, some regulatory bodies that employ the use of First In First Out (FIFO) executions, such as the US, make hedging virtually impossible.
How to Choose a Broker for Hedging
When selecting the best hedging broker, several factors come into play, including fees, spreads, slippage, and the broker’s overall policy on hedging.
Fees and Spreads
Since hedging involves opening two opposing positions on the same market simultaneously, traders will have to pay double the commission if there is any. They’ll also be paying the spread on both positions and any other fees that may arise, including overnight fees or trading fees. Keeping these costs down is essential for a successful hedged position.
Slippage and Requotes
Another factor to consider is slippage, which refers to a price change between order and execution that can happen in volatile markets. Requotes are minor price changes that traders should try to avoid. Many top forex brokers offer no requotes or hidden fees, along with Electronic Communication Network (ECN) execution, making pricing more stable and transparent, and reducing the chance of slippage.
Best Forex Brokers Allowing Hedging
Considering the numerous options available for traders seeking brokers that allow hedging, we’ve researched and compiled a list of some of the best brokers for hedging purposes.
- FXTM: Best all-around broker with high floating leverage and fast execution.
- FP Markets: Offers ECN trading with leverage up to 1:500.
- Eightcap: Competitive pricing and excellent daily videos.
- BlackBull Markets: Best ECN trading environment, allowing scalping and hedging.
- AvaTrade: Highly regulated with a choice of fixed or floating spreads.
Hedging Strategies and Styles
Hedging strategies can be classified into two categories: “dumb” hedges (also known as simple hedges) and “smart” hedges (also known as complex hedges).
Dumb or Simple Hedging
A dumb hedge involves taking a buy and sell position of equal size simultaneously in the same asset. This strategy locks in any floating profit or loss, but commits to a day-to-day capital bleed, as swap rates on leveraged overnight positions must be paid on both positions. Dumb hedges serve no purpose, and traders benefit more by closing a trade rather than taking an opposing position of equal size in the same asset for the same net result.
Smart or Complex Hedging
A smart hedge, on the other hand, involves taking a second position in a correlated asset, potentially serving as an intelligent risk management strategy. However, it also increases overall risk and is best suited for skilled traders who understand financial markets.
Complex hedge strategies can be divided into the following styles:
- In Forex, taking long and short positions in the same currency in two different pairs or in distinct but correlated currencies.
- Using an index or basket to hedge against a long or short trade in an individual asset.
- Cross-asset class hedges in correlated assets, such as being long in crude oil and short in the Canadian dollar.
- Long/short strategies within the same asset class, such as being long in 10 bullish stocks and short in 10 bearish stocks. This market-neutral approach generates profit regardless of the wider market’s performance.
Hedging Pros and Cons
There are both advantages and disadvantages to using a hedging strategy.
- Smoothing out drawdowns
- Potentially smoother equity curve
- Reducing overall profit
- Increasing trading costs
- Psychological overcomplication
Only one country has hedging regulations that impact retail forex and CFD traders: the United States. The US imposes a rule known as FIFO (first in, first out), which states open trades in the same asset of the same size can only be exited in the order they were opened. This regulation is enforced by the National Futures Association (NFA) on all US-regulated forex brokers.
Although the FIFO regulation is often cited as banning hedging in the US, this is not entirely accurate. The regulation only applies to trades in the same assets (simple hedges) and trades of the same size. Complex hedges are not affected by this regulation.
Simple, or “dumb,” hedging is pointless and generally used by inexperienced traders to avoid taking losses. It’s better to use hard stop losses and accept that losses will occur rather than resorting to simple hedging strategies in the same asset.
On the other hand, complex or “smart” hedging can make sense, especially for long-term traders or investors with a time horizon of months or years. Hedging can be particularly helpful in building trading strategies in stocks, where options on an underlying index can be used to hedge downside risk.
In conclusion, understanding the various aspects of hedging and the forex brokers that allow it is crucial for traders looking to employ this risk management strategy. By carefully considering the pros and cons, regulations, and strategies associated with hedging, traders can make informed decisions about whether to incorporate hedging into their trading arsenal.
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